Local Capital Market: Better Late than Never

As the EPRDF’s Executive Committee has decided to partially or fully privatise major state assets, the question has reverted to how transparent and fair the process would be. Setting up a capital market would be the best way of addressing this, but only if handled cautiously and carefully, writes Abenet Bekele (abenet_be@yahoo.com), chief strategy and corporate communication officer at ECX and IFC-Milken Institute Fellow.

After the swearing in of Prime Minister Abiy Ahmed (PhD), the country has been filled with hope, aspirations and enthusiasms. People have started to think freely, speak their minds without reservation and to share their thoughts without limitations – even about ideas that had not previously been welcomed by the Revolutionary Democrats.

Although Abiy has made outstanding strides in helping the country stabilise, relating to the people, reshuffling his cabinet – both in the military and security front – a lot is still expected from him in meeting the demands of the citizens.

The past month has brought new and unexpected announcements from the ruling party. The news completely diverted the attention of the nation and filled the air with optimism, doubt, confusion and concerns in relation to decisions made by the coalition in the economic and political fronts.

The decision to partially privatise some of the nation’s most prominent assets including the national flag-carrier Ethiopian Airlines, the monopoly telecom operator Ethio telecom, Ethiopian Shipping & Logistics Services Enterprise and the Ethiopian Electric Power Corporation took many by surprise.

These decisions are fundamental – this is a shift from the old, long-stuck thinking of public driven development to a policy that embraces the private sector in major revenue-generating sectors.

The current reality demands that concerted efforts be made to alleviate the problems at hand. A strong role played by the private sector is essentiall more than at any other time today.

Creating job opportunities is also crucial and a priority for Abiy’s government. More jobs should be created for the youth and the young graduates that are joining the labour market in droves, spurned by the over 30 universities and colleges in the country. The success of the new government may be measured by how many jobs are created quarterly and yearly.

The issue needs to be systematically addressed with care and urgency to make the current changes sustainable.

These issues need to be addressed by quickly mobilising capital and know-how to create jobs, deal with the long-outstanding issues of governance, creat efficiencies in local investments, foreign direct investments and tapping into the potential of the diaspora population. The idea of privatisation probably has similar goals in the short-term by relieving the current foreign currency crunch of the nation.

One of the significant issues that have been raised by many in relation to privatisation is the how part. The transfer of shares must be conducted in a transparent, accountable,  orderly and fair manner. The process should also address how these minority shares are transferred to Ethiopian nationals, local businesses, employee associations, the diaspora and foreign companies.

There is an active advocacy for the creation of a well-functioning local capital market to trade securities in a modern, fair and transparent way, but that issue has been ignored for long. Now, the country has reached a point where it needs a trading market and it may be inevitable. The Prime Minister has, during his last appearance in parliament, acknowledged the importance of capital market and the concept of privatisation.

So what is a local capital market?

The history of capital market tracks back to the 17th century and it has been operating in various forms ever since. The exchanges like the London Stock Exchanges, New York Stock Exchange (NYSE) and Bombay Stock Exchange have been in operation for over a century.  At least in Europe, these exchanges have played essential roles in the Industrial Revolution by providing capital for new ventures.

In simple terms, a capital market is a form of a financial source that supplies the necessary cash for investments in an economy, and supports ventures in areas that are too risky for commercial banks to touch.

In the Ethiopian context, commercial banks are the sole financial source of capital as they traditionally channel funds deposited by their customers to borrowers of a business venture. Financial markets link investors the enterprises, providing a platform and options to businesses for sources of fund for their ventures.

Financial markets could be of two forms – capital and money markets. Capital markets exchange financial instruments that mature in periods that are one year or more, while money markets trade instruments that mature in one year or less.

Financial markets can also be categorised based on the instrument type that they use, debt or equity, and the nature of issuance – in the primary or the secondary markets. While derivative markets are intended for risk management purposes, as other means of raising capital. Issuers, either entrepreneurs or corporations, may issue stocks or bonds to raise funds for their new business idea in the primary market. But once the instrument is issued, it would be traded in the secondary market between buyers and sellers.

The advantages of a capital market for Ethiopia at this junction of economic transformation cannot be underestimated.

Local companies need funding to expand their business – the capital market can provide alternative funding source apart from banks. Through capital market, the corporate sector and government can source long maturing funds with relatively competitive prices from a broad base of investors. It also can generate finance for innovative, new and riskier business ideas and initiatives at a relatively low cost.

A capital market encourages new business ideas to mushroom, creativity and innovation to flourish and help market efficiencies to improve. Any novel business idea that matures through time is presented in the form of initial public offering (IPO). Given the low level of innovation in our country, and the high number of small and medium-sized enterprises (SMEs) in the economy, this window can be designed creatively in a way that addresses these issues.

Exchanges can also be a vehicle to transfer ownership of companies, seamlessly and in an orderly fashion, by listing them in the market and trading their shares to local investors.

By promoting a capital market, the domestic economy will gain access to local currency financing rather than depending on foreign currency denominated loans. The government can also finance its fiscal deficit by borrowing from local markets with low cost for national development agendas. This reduces foreign exchange risks on foreign loans and at the same time help manage inflation.

The capital market creates a venue where investors meet fund-seekers, thereby facilitating better returns for investors who provide the cash for companies and business who exhibit viable ventures.  Based on proper risk profiling and due diligence, investors can secure a better return on their investment than what is available to them in bank deposits.

Establishing a capital market will help our nation regenerate the existing fragmented and uncoordinated share market to a higher level of organisation and sophistication.

This market can also be a reliable vehicle for institutional investors including pension funds and insurances to invest funds where they may be able to gain sound returns for their clients.

The vibrant changes in the country characterised by economic growth, population growth and urbanisation could be an opportunity for these institutional fund managers to engage in reliable and potentially profitable ventures. A capital market can facilitate an infrastructure investment financing that supports the nation by channelling these investments to strategic sectors of the economy.

A well-developed capital market can also serve as a tool for monetary policy management by actively supporting the government with macroeconomic management.

But there are challenges to developing a capital market.

It depends on the economic development level of the country and its structural arrangement of the economic policy. It is highly correlated with the size of the economy, saving rates and income of citizens. By African standards, except in few cases, many emerging stock exchanges are low in equity market capitalisation and liquidity of their secondary market.

It probably continues to be a challenge to develop a liquid and active market in the short term. As a result, it may take longer to bring positive effect on private-sector-led growth and long-term development.

However, capital market flourishes relatively easily where there are sound macroeconomic and supportive policies, solid legal and institutional frameworks and systems that create strong investors’ confidence.

Asymmetry of information in the market is another area of risk which can undermine the integrity of the market. Lack of adequate regulation, sufficient market infrastructure, lack of supervisory and monitoring capabilities would make it hard to function. On the other hand, improving the investment climate, establishing accounting frameworks, taxation regulations, property rights, bankruptcy procedures and competition laws are critical for this development.

The financial market demands a modern trading platform, central security depository, market information dissemination mechanisms and clearing facilities similar to Ethiopia Commodity Exchange (ECX).

Given the low levels of domestic savings, lower per capita income and low-risk appetite of institutional investors in Ethiopia, it may require the direct participation of foreign investors and cross-listings in other markets to create more capital source and liquidity to the market. This requires caution in protecting sudden capital outflows.

To catch up with the fast-moving global finance movements and financial market dynamism, capital market creation should be started now along with privatisation initiatives. Detailed studies and structural reforms are mandatory in areas of financial reporting, tax policy, market infrastructure, regulatory framework and investment law to create a fertile ground for local capital market development.

If implemented carefully and with the necessary cautions, a capital market can attract capital and create jobs by reducing the cost of borrowing, igniting economic growth of the country as well as tapping into global equity markets.

By Abenet Bekele
Abenet Bekele (abenet_be@yahoo.com), chief strategy and corporate communication officer at ECX and IFC-Milken Institute Fellow.

Published on Jun 30,2018 [ Vol 19 ,No 948]



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